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By John Helmer in Moscow

The buyout offer for minority shareholdings in Toronto-listed High River Gold (HRG:TSX) now looks double-doomed. A combination of minority shareholders has now formed that is numerically strong enough to prevent the Russian Severstal group, owned by Alexei Mordashov, from suceeding in his 22-cent offer for the 42.7% of shares he doesn’t already control. And Mordashov himself, and his Severstal group, appear to be under strict bank loan covenants to preclude any new deal worth $150 million, and thus in no position to raise their bid high enough, or borrow more money, to make the buyout possible.

HRG will hold its annual general shareholder meeting on June 30 in Toronto. Although the buyout bidding has been the dominating topic of shareholder talk for weeks — Mordashov raised his offer from 18 Canadian cents to 22 cents on June 9 — no action on that issue is expected. In the meantime, there have been threats of litigation against Severstal and the HRG management, while the Ontario Securities Commission is considering a shareholder complaint filed on April 24.

An HRG board deadline for a delisting review has been fixed for August 17. If Mordashov’s buyout offer of 22 cents fails by then, there will no delisting top speak of.

HRG has four operating gold mines in Russia and Burkina Faso, and two mine projects in development. It has currently attributable production of about 300,000 ounces per annum, and is cashflow positive. Attributable gold reserves were estimated in February by Dan Hrushewsky, HRG’s investment relations director, at 2.2 million oz, with silver reserves at 5.2 million oz. A subsequent release from the company on March 17 reported a MICON expert audit of gold reserves at the Zun-Holba and Irokinda mines (Buryat region of southeastern Siberia). Altogether, counting the Bissa gold project in Burkino Faso and the Prognoz silver project (Sakha region of fareastern Siberia), and converting silver reserves into gold equivalent, HRG’s gold equivalent reserves and resources, on the Canadian NI 43-101 basis, add up to 6.1 million oz.

After financial and operating problems thatdamaged production and share price were resolved by the first quarter of this year, sources close to the company are projecting revenue this year of $291.2 million, compared to $167.8 million for 2008. Ebitda is expected to jump from $28.6 million to $108.7 million, while the bottom-line will go from a net loss of $53.2 million last year to a profit of $64.3 million this year. Since the Mordashov buyout offer was raised, the share price has stuck between 21 and 23 cents, and the charts show very low-volume buying and selling.

“If noone is selling now, why will they sell in six weeks’ time?” comments a stakeholder, who claims to havemobilized an alliance of minorities holding at least 10%, and possibly as much as a majority, of the HRG freefloat. In order to represent their consensus in public, he has requested anonymity. A check of other shareholders confirms the existence of the informal alliance and the size of its stake.

Thealliance argument is double-edged for Mordashov and the Severstal Resurs division, which acquired HRG last November, but is believed by the minority shareholders to have been running down the share price, with the aim of taking the company private. On the one hand, the Severstal management has made a big success of its operational takeover. “They’ve done a great turn-around job,” the alliance spokesman says.

On the other hand, that success makes HRG less vulnerable to Severstal’s pressure on debt, and far more valuable to current shareholders than Mordashov is willing to concede — or share. The outcomeis that HRG is now generating enough cashflow to pay off its short-term debt. “Any shortfall,” according to one stakeholder, “would be in the range of say $10-$30 million, and this could be easily funded by minority shareholders in a placement.” Another international shareholder group says it has independently come to a similar conclusion. Together, they agree that, based on any available method of valuation, HRG is trading at a discount of between 50% to 80% to its peers. A calculation of HRG’s current enterprise value (EV) to gold production, takes into account the premium currently assigned in the market to goldminers with gold for sale, rather than gold in the ground: this indicates that the HRG ratio of EV to production is 1,593. Two other Russian goldminers, Polymetal and Peter Hambro Mining, are currently at 5,470 and 5,043, respectively. In their latest gold asset acquisitions, Polyus Gold, Russia’s leading goldminer, set an EV/production ratio for Kazakh Gold of 7,011; while Polymetal’s acquisition of Varvarinskoye (also in Kazakhstan) was 6,227.

The number-crunching makes the case for holding on to HRG, and allowing the market to drive up the share price to reach peer level. One shareholder says his advice to Mordashov is “Admit the mistake of trying to go private. Relax. Sit back, consolidate assets, and you will have the third largest goldminer in Russia.”

Analysis of recentmarket trading in HRG suggests, according to Ryan Dodd, that the small number of shares traded at 22 cents represents only 1% to 2% of the free float. An American, Dodd was one of the founding partners of DBM Capital, a three-year old offshore investment fund with offices in Moscow. DBM has recently consolidated its asset management operations with Specialised Asset Management (SAM). Dodd believes it is now mathematically impossible for Mordashov’s buyout to succeed. “There has been a bid in the market for a week now of over 5% of the company total shares at $0.215. There are no sellers.”

But at what price might the minorities reconsider? A worst-case calculation by the minority alliance has consideredthe possibility of a new share issue and dilution to raise cash for operations and debt cover. The spreadsheet of the calculation suggests that on the 2009 projections, without counting the value of the large but undeveloped Prognoz silver deposit in northeastern Russia, the threshold might be 86 US cents (99 Canadian cents). Other shareholders believe this is much too low to be realistic for them. A month ago, Minesite reported that shareholders with about 6% of the non-Severstal float, or about 27% of the institutional positions, ranged in their target sell price from a low of 50 Canadian cents to a high of C$1.28, with a current bullboard consensus forming around C$1.

Severstal Resurs has defended its 18-cent offer, telling Minesite: “At the moment of our request to HRG [May 19] the price was 14 Canadian cents. That is, our price was 28.6% higher than the market price.” Asked to respond to the claim from other shareholders, as well the OSC complaint, that Severstal had been trying to hold HRG’s price down, in order to reduce the price of the buyout, the spokesman said: “We have neither bought nor sold HRG shares since August. And we have not sold any shares at all. So we could not suppress [the price of] HRG shares.”

Public information about Mordashov’s financial position has grown since then. Disclosure of loan covenants covering the entire Severstal group has established,to cite one, that:
“Severstal shall not and shall ensure that its Material Subsidiaries do not (in each case disregarding sales of stock in trade on an arm’s-length basis in the ordinary course of business and assignments of or other arrangements over the rights or revenues arising from any Steel or Ferrous Metal Contract) sell, lease, transfer or otherwise dispose of, to a person other than a Subsidiary or Severstal, as the case may be, by one or more transactions or series of transactions (whether related or not), the whole or any part of its revenues or its assets which have the aggregate value in excess of U.S.$150,000,000 or the equivalent thereof in any 12 month period, if such sale, lease, transfer or disposal has a Material Adverse Effect.”

If Mordashov were to consider a low target sell-price of 86 US cents, the cost to Severstal would be almost $220 million — more than Mordashov can afford. If the restrictive covenant of $150 million applies, the highest price Mordashov can go towards the HRG minorities appears to be 59 cents (68 Canadian).

If the current bid fails, Mordashov can raise it to his bankers’ limit. But most of the minority stakeholders are calculating that this will still fall short of a significant share sale. The spokesman for Mordashov and Severstal Resurs was asked by Minesite to explain what impact the loan covenants may be having; why they still want to take HRG private; and at what price they believe this can be effected. The spokesman responded that they have reviewed the questions, and decided “not to comment.”

The minority shareholder consensus now is that the best option for Mordashov, as well as for themselves, is to “let the bid lapse; do nothing; and make a fortune after keeping HRG public.”

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